FDIC Failed Banks are Escaping Big Penalties

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(Reuters) - Like many banks engulfed by the mortgage crisis, First National Bank of Nevada specialized in risky home loans that didn't require borrowers to prove their incomes. When the housing bubble burst, First National got crushed in 2008 under the weight of bad loans that it could no longer resell to investors.

Last year, the Federal Deposit Insurance Corporation sued two former senior executives of the defunct bank for alleged negligence and breach of fiduciary duty, hoping to recover nearly $200 million in losses that it tied directly to those executives' decisions. The two men denied wrongdoing and settled for $40 million.

But they didn't pay a dime.

Instead, the federal agency - which is better known as a regulator that seizes control of failing banks and provides deposit insurance for consumers than for its prosecutorial endeavors - is still fighting in court to collect that money from Catlin Group Ltd., a Lloyd's insurance syndicate. Catlin provided an equivalent of malpractice insurance to First National's executives, but the insurer denied liability for the executives' alleged mistakes.

The case illustrates complex legal maneuvering as the FDIC steps up efforts to pick through the detritus of the financial crisis, and to recoup at least some of the nearly $87 billion costs to its deposit insurance fund from the collapse of about 400 federally insured banks between 2008 and late 2011. The First National Bank failure cost the fund $900 million.

Concerns about whether the FDIC's strategy isn't aggressive enough in such cases at least partly echo criticism levied at other regulators and enforcement agencies for being too lenient.

Over the past 18 months, the FDIC has filed 22 lawsuits targeting personal finances of former executives, their insurance policies, and sometimes their spouses' assets, in an attempt to claw back some of the money, and to deter reckless banking practices in the future.

Of the lawsuits filed so far, none has gone to trial yet, and three have been settled. A look at the three deals suggests the FDIC is prepared to accept a fraction of the alleged damages as a settlement while some former executives deny wrongdoing and escape significant financial responsibility for bank failures.

AVOIDING COSTS

The primary targets of the lawsuits aren't so much the former executives' wallets, but rather the insurance policies most banks take out to shield their officers and directors from claims of negligent management, according to court documents and interviews with lawyers.

FDIC officials say their settlement strategy is driven by the need to maximize recoveries, and to avoid costs for potentially losing litigation. In response to questions, the FDIC says its "actions do send a message, and settlements do result in directors and officers being held accountable." The agency added, "the reason that we have not gone to trial on any of these cases yet is primarily attributable to the fact that we are still early in the crisis."

But some critics, including a prominent senator, have faulted the agency for settling for too little and for failing to set precedents that could deter bankers in the future.

"Their recoveries should be much greater, and they should never allow a CEO to walk away with the idea that crime pays," says William Black, who as litigation director for an agency later folded into the FDIC, filed many of the hundreds of government's lawsuits against executives resulting from the savings-and-loan crisis of the 1980s.

Founded in 1933 in response to the bank failures and savings losses of the Great Depression, the FDIC is just one of several regulatory agencies digging through the aftermath of the financial crisis. Unlike some other regulators, the FDIC is credited with spotting the mortgage bubble early on, and with warning banks about it. What's more, a bulk of subprime loans originated with lenders that weren't regulated by the FDIC.

"BEAT THE SYSTEM"

Investigations into some of the bank failures on the FDIC's patch have only recently been completed or are about to be, auguring a greater number of lawsuits, agency officials and outside lawyers say.

As of mid-February, the federal agency had authorized litigation in connection with more than 27 failed banks, in addition to the 22 lawsuits already filed. Last year, the FDIC says it collected $240 million from professional liability claims, a figure that represents most of such collections by regulators so far in the aftermath of the financial crisis. Following the savings-and-loan crisis, banking regulators recovered about $1.3 billion in damages from former directors and officers, according to an estimate by Dechert, a Washington law firm.

The FDIC's biggest settlement so far targeted Washington Mutual. The FDIC sued several former executives, accusing them of gross negligence in pursuing high-risk lending that eventually caused the bank to lose billions of dollars and collapse in 2008. The FDIC sought $900 million in damages, but last December settled for $95 million, most of it covered out of insurance, with several executives contributing less than $500,000 between them.

The FDIC said the December settlement was "suitable" and provided "a significant return" while avoiding a costly court battle. But others criticized the deal. Sen. Carl Levin, whose subcommittee's investigation of the financial crisis included a scathing chapter on WaMu, said the settlement "shows again how bank executives can beat the system." The former executives denied wrongdoing.

In pursuing these claims, the FDIC acts more like a bankruptcy receiver whose main goal is to collect money, not punish executives. But with the dearth of criminal prosecutions in the aftermath of the financial crisis, the FDIC's liability claims carry a bigger weight. The Justice Department, for instance, closed its WaMu probe in August without any charges.

IGNORED WARNINGS

The FDIC says its lawsuits help improve banking practices and that its investigators have made criminal referrals in cases where they suspected outright fraud.

The First National case provides a window into these legal struggles.

Before it collapsed in 2008, the bank was part of a holding company that expanded through acquisitions and new ventures, mostly in Nevada and Arizona.

Though initially conservative in its lending outlook, First National got swept up in the residential-loan fever early last decade and billed itself in press releases as "Home of Alt-A lending", a category just a notch above subprime, according to court documents. First National was "extremely aggressive" and set aside normal caution and underwriting standards, according to the FDIC lawsuit filed in August in a federal court in Arizona.

When the housing market softened, First National's management ignored warnings from the bank's own employees and from government regulators pointing out the inherent risks of the lending strategy, the lawsuit says. In bringing its negligence case, the FDIC singled out Gary Dorris, the holding company's former CEO, and Philip Lamb, who was the executive vice president. The two "continued this downward spiral even after investors told them they would not purchase loans" the bank kept churning out, the complaint says.

In fact, Lehman Brothers, which itself eventually collapsed triggering the worst days of the financial crisis, rang alarm bells about the quality of First National's loans as early as 2007. In a lawsuit filed in an Arizona state court, Lehman alleged that the bank had sold it mortgages with numerous misrepresentations about the borrowers' finances, employment and the nature of the property. Lehman sought $18 million in damages.

First National denied the allegations and settled for an undisclosed amount. Jay Coleman, a lawyer who represented First National, declined to comment on the settlement, citing confidentiality issues.

Dorris and Lamb also denied wrongdoing in the FDIC lawsuit. The bank failed not because of any negligence on their part but because of "the unprecedented disruption of the real estate market," they said in a court filing. Ronald Glancz, a lawyer who represented them in the case, said they were unavailable for comment. "Everyone wants to put this behind them and get on with their lives," he said in an email.

But as part of a complex settlement, they agreed to a judgment of $20 million against each of them, a figure derived from "what a jury might reasonably award (the FDIC) as damages," according to a September court motion. As part of the same deal, federal regulators promised not to collect that money from the two former executives, and instead to go after Catlin, the Lloyd's syndicate.

Months before the lawsuit was filed, federal regulators held talks with lawyers for several former executives, including Dorris and Lamb. During those talks, the FDIC hammered out a deal that involved $3.5 million in penalties from two other executives and a $7 million payment from another insurer, Chubb Group, according to an FDIC court filing. The two other executives also signed consent orders with the Office of the Comptroller of the Currency banning them from working at federally-insured banks in the future.

But the FDIC targeted Dorris and Lamb for the lion's share of the damages. Shortly before First National collapsed, its Chubb insurance policy had expired. With its risk exposure growing, the bank had trouble finding another insurer, according to court documents. Eventually, the bank signed on with Catlin, in exchange for a steep premium that the executives assumed would cover claims of negligent conduct predating the start date of the policy, according to a lawsuit filed by the FDIC against Catlin.

When the insurer balked at settling those claims with banking regulators, the FDIC sued Dorris and Lamb, settled with them for $40 million, and then turned around and sued Catlin for that money. Dorris and Lamb didn't face banking bans or any other penalties.

In a court filing last month, Catlin denied liability, arguing that "coverage for the events in question (is) specifically excluded by the terms of the policy." The battle continues. A Catlin spokesman declined to comment further. In a written response to questions, the FDIC said the First National settlement is "a good example of directors and officers being held accountable."